Customizing your target-date option: Mercer s Retirement Choice Portfolios

Transcription

1 Customizing your target-date option: Mercer s Retirement Choice s

2 Background Defined Contribution (DC) plan sponsors are faced with many challenges as they design a robust menu of investment choices for their participants. Such challenges include offering participants a broad range of core investment options that they can choose and diversify among on their own, as well as prediversified options such as target-date funds also known as lifecycle funds that offer participants a simple, single fund diversification option. Over the past several years, target-date funds have evolved from a supplementary product offering to a predominant vehicle in many plans investment lineups. Driving factors behind this trend include the desire to provide a simplified allocation approach and the establishment of target-date funds as a Qualified Default Investment Alternative (QDIA) under the Pension Protection Act (PPA). While these factors raise important considerations, studies have consistently shown that asset allocation decisions, rather than individual manager selections, can have the greatest impact on an investor s total long-term return. In light of this evidence, many plan sponsors are considering Mercer s Retirement Choice s for their custom target-date offering in order to better assist participants with the asset allocation decision-making process. In fact, as the usage of target-date funds has proliferated, so have the number and types of targetdate funds. Plan sponsors can now choose among: Actively managed vs. passively managed Registered vs. non-registered (i.e., collective investment trusts) Single manager vs. multi-manager Aggressive vs. conservative (equity glide-path construction methodologies) Impact of the Pension Protection Act (PPA) of 2006 Passage of the PPA of 2006 brought broad-sweeping changes to DC retirement plans. The PPA, in part, directed the Department of Labor to issue regulations providing employers relief from fiduciary liability when selecting default investments for employees who do not direct their own investment allocations. The final regulation outlines conditions that must be satisfied in order to obtain this safe harbor relief. As part of the safe harbor, plan-directed assets must be invested in a Qualified Default Investment Alternative. While the final regulation does not identify specific investment products, it describes mechanisms for investing participant contributions without affirmative participant direction. The intent is to ensure that a QDIA is appropriate as a single investment capable of meeting a participant s longterm retirement savings needs by investing in a mix of equity and fixed-income investments. The final regulation defines each of the following as an approved QDIA: A product with a mix of investments that takes into account the individual s age or retirement date (such as a target-date fund) An investment service that allocates contributions among investments to provide an asset mix that takes into account a specific individual s age or retirement date (as with a professionally managed account service) A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (such as a balanced fund) Standard off-the-shelf options vs. custom approaches (e.g., Mercer s Retirement Choice s) 2

3 For a fund to qualify as a QDIA, it must be a mutual fund or any other fund or portfolio of funds managed by an investment manager, plan trustee, plan sponsor, or a committee comprised primarily of employees of the plan sponsor that is a named fiduciary. As for capital preservation funds (e.g., stable value funds), long a favorite default option, the regulations created a safe harbor for certain investments prior to December 24, 2007, but permitted their use as a QDIA going forward only for particular short-term investments. A report by Cerulli Associates, Pension and Investment Consulting: Insight for Asset Managers in DB and DC, August 2008, estimates that with the momentum generated by the passage of the PPA target-date fund assets are projected to exceed more than $1.1 trillion by the end of 2012, more than three times the projected estimate for year-end In addition, Callan Associates conducted a survey, Impact of the Pension Protection Act: Defined Contribution Plan Sponsor Survey, March 2008, of nearly 90 large plan sponsors and found that: 7 preferred using a QDIA for their plan, with target-date funds being the QDIA of choice 1 reported using (or intending to use) a custom mix of funds for their QDIA, up from 1 in 2007 The movement toward target-date fund customization is likely attributable to added flexibility in the QDIA regulations that allow plan sponsors to create a custom asset allocation mix without necessarily hiring a professional manager. Therefore, plan sponsors can more easily leverage their existing lineup of investment options and potentially provide a more cost-effective option compared to an off-theshelf alternative. Mercer s Retirement Choice s help plan sponsors and their consultants or financial advisors do just that: design a custom target-date option that meets the rules and regulations surrounding QDIAs. For greater details about the Pension Protection Act and the Qualified Default Investment Alternative provisions, you should consult your investment consultant/advisor or retirement plan counsel. Standard off-the-shelf vs. custom target-date options First, let s define these two options: Standard off-the-shelf target-date options are available from many well-known investment managers, such as Vanguard, T. Rowe Price, Fidelity Investments, and JP Morgan. These investment managers have constructed their products based on years of internal and external analysis and use their own proprietary investment vehicles within their target-date funds. Furthermore, they take different approaches to managing the underlying asset allocations, rebalancing, and glide path methodologies for their suite of retirement funds. Custom target-date options, such as Mercer s Retirement Choice s, are designed by the plan sponsor or their consultant/advisor and are managed according to a predetermined retirement date. These options are constructed to address the specific needs of the plan s participants and are often based on plan demographics (e.g., participants level of investment knowledge, age, participation rates, and access to other retirement savings vehicles). Custom target-date funds consist of a combination of the plan s core investment options, over which the plan sponsor has complete control with respect to ongoing and strategic asset allocation, rebalancing, and glide path methodology. Since the suite of funds is part of the plan s core lineup, the plan sponsor also has control over selecting and monitoring the managers. Custom target-date funds can offer plan sponsors numerous advantages over the standard off-the-shelf option, including the ability to: Control the asset allocation, rebalancing, and glide path. Ensure that all underlying funds meet the plan s Investment Policy Statement at all times. Easily monitor the underlying investment options and managers of the target-date funds since they re already part of the core investment lineup. (In a standard off-the-shelf option, monitoring underlying managers in the target-date funds, in addition to the plan s core lineup of funds, can place a strain on resources and add considerable efforts to the due diligence process.) 3

4 Change investment managers and strategic asset allocations. Plan sponsors seek best-in-class investment managers for their core investment lineup, picking from multiple fund companies. (Standard off-the-shelf target-date funds are often restricted to that fund company s proprietary options. This constraint can prevent them from being a best-in-class solution. Additionally, a fund company s revenues may be contingent on the underlying funds employed, thus creating a potential conflict of interest. Even those targetdate funds utilizing outside sub-advisors may face a conflict due to revenue-sharing agreements. Furthermore, the plan sponsor or their named co-fiduciary, advisor, or consultant can make timely strategic asset allocation changes in order to adjust to dynamic market conditions. This is not possible in the standard target-date option as the investment manager makes all strategic asset allocation decisions.) Achieve diversification since a customized solution enables plan sponsors to include actively managed and low-cost passively managed strategies. (Selecting a standard off-the-shelf product likely means using that manager s proprietary funds as the underlying options. This may create significant overlap and reduce and/or minimize diversification.) Provide straightforward employee communications since all of the underlying investments for the custom target-date funds are already being communicated to plan participants as part of the plan s core investment menu. (Using a standard off-the-shelf option creates a second set of funds for the plan and necessitates the communication of those options to participants. Furthermore, some participants may question why the same underlying funds are not available as part of the plan s core investment lineup.) Manage the cost of the custom target-date funds by potentially being able to leverage institutional pricing of their current core investment options. An Overview of Mercer s Retirement Choice s Offering a lineup of investment options that appeals to employees with varying levels of investing experience can be challenging for plan sponsors. In an effort to complement a plan s traditional core lineup of investment options, pre-diversified ( ready-mixed ) portfolios offer simple, one-step diversification, which can appeal to many employees, especially those with little investment experience or time to monitor their retirement accounts. Pre-diversified portfolios enable employees to more easily diversify their accounts by selecting one fund that most closely matches their own investment profile. While standard off-the-shelf pre-diversified investment options are widely available, they may not fit the asset allocation requirements and needs of all plan sponsors. For greater customization, Mercer offers its clients target-date Retirement Choice s (RCP), a systematic allocation tool that utilizes some or all of the funds in each plan s core investment lineup. Retirement Choice s give plan sponsors several advantages, including an ability to: Maintain complete control of the strategic and tactical asset allocation decisions across the portfolios Make timely allocation changes in response to changing market conditions Offer flexible rebalancing options every 3, 6, or 12 months, or not at all Utilize flexible glide path construction Establish portfolios in 5- or 10-year increments Use all or a portion of the plan s core investment options Customize portfolio names to reflect the company s name (e.g., Retirement Choice 2010) Base expense ratios on a weighted average of the expense ratios of all the underlying investments 4

5 Retirement Choice s enable plan sponsors and their participants to achieve diversification in a single step. A well-diversified portfolio that includes several different asset classes and styles can help reduce volatility while providing a more efficient risk/return profile than a non-diversified portfolio. Of course, there is no guarantee that diversification will provide a profit or prevent a loss in all economic/market conditions. Participants who are interested in one-step diversification can simply select the portfolio with the target year that most closely matches their anticipated date of retirement. In order to reduce risk exposure as the target date nears, the portfolio is automatically reallocated to more conservative assets pre-selected by the plan sponsor or the company s named consultant/advisor. The table below shows a hypothetical sample asset allocation for Retirement Choice s, which are provided in five-year intervals from and also includes a Maturity for participants who have already reached their target retirement date. Each date indicates the anticipated date when the portfolio s investors expect to retire or otherwise begin withdrawing assets from the account. The principal value of the funds is not guaranteed at any time, including at the target date. Sample Target-Date s The s are reallocated to the new target percentages every five years, generally reducing risk exposure over time. Most Aggressive Most Conservative 2010 Maturity Domestic Equity Large-cap Growth Large-cap Blend (passive) Large-cap Value Small/Mid-cap Blend (passive) % International Equity Developed Emerging Markets % 15% Fixed Income Core Bond TIPS High Yield Foreign Bond Capital Preservation Stable Value / Money Market 1 15% 1 5% Total Domestic Equity Total International Equity Total Fixed Income Total Capital Preservation Total % % %

6 The Benefits of Mercer s Retirement Choice s With the uncertainty surrounding future Social Security benefits and the declining number of traditional defined benefit plans, defined contribution plans are becoming the centerpiece of most workers retirement savings strategy. As such, plan sponsors must have a heightened awareness of the products and services available to them, so they can equip their participants with the resources they need in an effort to successfully meet their retirement objectives. As you ll see below, Retirement Choice s carry several benefits for both the plan sponsor and participants: Plan sponsor benefits Participant benefits No unitization costs, as portfolios are systemdriven allocation tools Ability to leverage ongoing oversight and due diligence of core investment options Freedom to change underlying funds and offer access to best-in-class investment managers The ability to make timely strategic and tactical asset allocation changes during volatile market environments Customized asset allocation, rebalancing, and glide paths to fulfill plan sponsor and participant needs A simplified retirement savings strategy through single-step diversification Age-appropriate asset allocation that reduces risk over time and rebalances automatically The convenience of using familiar investments A low-cost investment option Employer oversight of underlying managers Web-based reporting shows performance for, not only each Retirement Choice, but for the underlying investment options as well Streamlined employee communications Potential of increased plan participation rates and retirement plan marketability Full fee transparency of underlying investment options Ability to attract and retain talented employees seeking competitive retirement benefits Assurance that all underlying funds meet the requirements in the Investment Policy Statement 6

7 Conclusion If you are a plan sponsor with a desire for flexibility in creating a customized option for your participants, and a concern about the restrictions of an off-the-shelf solution, Mercer s Retirement Choice s may be right for you. In addition to helping you create your custom target-date solution, Mercer can also provide the education and communication participants need to better understand these portfolios and make more informed investment choices. From on-site workshops to posters, postcards, and targeted s that drive action, Mercer can help you get the word out about your custom Retirement Choice s. We look forward to working with you and helping your participants prepare for retirement. Please do not hesitate to contact your Mercer representative if you have any questions. Important disclosures Diversification and rebalancing will not necessarily prevent participants from losing money; however, they may reduce volatility and potentially limit downside losses. This analysis is provided by Mercer s Investment Services Team to assist you in making decisions about the investment lineup offered by your retirement plan. This should not be considered investment advice as the Registered Representatives of Mercer's Investment Services Team are not registered investment advisors. You should not base your investment decisions exclusively on this information as MMC Securities Corp. is acting solely as a broker/dealer. You are strongly encouraged to consult with a financial advisor or consultant before making investment decisions about your plan s investment lineup. The views expressed herein are exclusively those of Mercer and are subject to change without notice. Mercer has not made any independent investigation as to whether any mutual fund is subject to investigation or legal action by any regulatory authority or other person and does not represent that any such fund has not been involved in any improper or actionable conduct, including but not limited to market timing or late trading of any fund. All funds have risks. Funds are subject to the volatility of the financial markets, including equity and fixed-income investments in the U.S. and abroad, and may be subject to risks associated with investing in high yield, small-cap, commodity-linked, and foreign securities. See a prospectus or offering statement for details. Certain funds share an administrative fee offset with Mercer for services rendered; these fees vary based on asset class and share class. Securities are offered by Mercer Securities, a division of MMC Securities Corp., Member FINRA/SIPC. Mercer HR Services, LLC, Mercer Human Resources Consulting, and Mercer Global Investments are all affiliates of the Marsh & McLennan Companies, Inc. The information provided herein does not represent the views of Mercer Investment Consulting, a separate subsidiary of Mercer Human Resources Consulting. 7

8 For further information, please contact Dave Tolve at FOR CONSULTANT AND PLAN SPONSOR USE ONLY Mercer Securities A division of MMC Securities Corp., Member FINRA/SIPC M /10 Copyright 2010 Mercer LLC. All rights reserved